Air Travel

Demand
IATA ECONOMICS BRIEFING No 9
Measuring the responsiveness
of air travel demand to changes
in prices and incomes
IATA Economics Briefing No 9:
AIR TRAVEL DEMAND

Mark Smyth
Brian Pearce

IATA, April 2008

Contents
00 Foreword by Giovanni Bisignani
page 03

01 Executive Summary
page 04

02 Report Outline
page 12

03 The Definition of Demand Elasticities

page 14

04 Key Types of Air Travel Demand Elasticities

page 18

05 Previous Estimates of Air Travel Demand Elasticities

page 22

06 New Estimates of Price and Income Elasticities of Air Travel Demand

page 24

07 Policy Implications
page 32

08 Conclusions
page 36

ANNEX A: THE INTERACTION BETWEEN PRICE ELASTICITIES

ANNEX B: LIST OF PREVIOUS STUDIES REVIEWED
ANNEX C: ECONOMETRIC MODEL SPECIFICATIONS
00 Foreword

The impact on demand of

every air transport policy
decision is an essential
consideration. Without it,
uncertainty over demand
leads to ineffective or
counter-productive decisions.
At the present time, the airline industry faces many
cost pressures. The industry has made remarkable
achievements in improving its efficiency. But cost
pressures continue, from record high fuel prices to
unjustified increases in charges from monopolistic airports,
to further taxes imposed by governments. Higher costs The results in this report also have important implications
inevitably lead to higher prices for airline passengers. for environmental policies. The aviation industry is
committed to a carbon-neutral – and eventually a carbon-
Therefore, it is crucial that reliable and appropriate
free – future. IATA’s 4-Pillar Strategy is already taking
estimates are available to assess how higher prices
action on emissions reduction measures focusing on
impact on the level of demand for air travel. This impact
technology, infrastructure, operations and those brought
will, of course, differ according to the level and location at
about by well designed economic instruments.
which prices are changed.
By contrast, rudimentary demand-side policies, such as
This report provides groundbreaking new research into
“green taxes”, that try to reduce emissions by raising
the sensitivity of air travel demand to changes in air travel
the price of travel for passengers are likely to fail. With
prices and incomes. It provides clear guidelines for the
passengers having far fewer possibilities to be able to
appropriate use of demand elasticities and robust and
reduce their travel on routes subject to such a tax at a
reliable estimates of their value.
national or supra-national level, such measures will provide
Air transport provides economic benefits not just for its easy revenues for governments, but will be ineffective in
passengers and cargo shippers, but also for the wider terms of their main objective.
economy by connecting businesses and individuals to
Understanding the impact on demand is the key to
global markets. Modern, just-in-time, global supply chains
effective policy decisions concerning aviation – for the
and multinational businesses are made possible by global
benefit of the industry, its users, the environment and the
airline networks. Yet governments often fail to recognise
wider economy.
this and continue to implement air transport policies
that are not in the best interests of the aviation industry
and the wider economy. Monopolistic airports that raise
charges but do not improve the services they offer will see
passengers quickly shift elsewhere. Governments that
impose new taxes on the industry are taking advantage Giovanni Bisignani
of less sensitive movements in demand at the national Director General & CEO,
level to raise revenues at the industry’s expense. IATA
01 Executive

Summary
The demand for air travel is sensitive to
changes in air travel prices and incomes.
However, the degree of sensitivity (i.e.
its demand elasticity) will vary according
to different situations. To ensure that air
transport policies are effective, reliable
estimates for demand elasticities are essential.
This report provides important new evidence on the size and appropriate use for
demand elasticities for air travel. It outlines the key findings from extensive research
undertaken on behalf of IATA by InterVISTAS Consulting Inc. to estimate air travel
demand elasticities applicable to a wide range of air transport markets1. It builds upon
previous academic research to provide new estimates of air travel demand elasticities
in different locations and scenarios, based on a comprehensive econometric analysis
using key air travel databases.

The aim of the study is to provide robust air travel demand elasticity estimates to ensure
that policy decisions related to issues such as liberalisation, airport charges, taxation,
emissions schemes, are made on the basis of appropriate and reliable evidence. It provides
important new estimates to ensure that price elasticity estimates do not underplay the
sensitivity of passengers to price and are used correctly.

Definition of Demand Elasticities

Demand elasticities measure the change in the quantity demanded of a particular good
or service as a result of changes to other economic variables, such as its own price, the
price of competing or complementary goods and services, income levels and taxes. They
provide a key insight into the proportional impact of different economic actions and
policy decisions.

This report estimates the demand elasticity of air travel under various scenarios and
locations. It focuses on three main types of demand elasticity:

1
The full report “Intervistas (2008), Estimating Air Travel Demand Elasticities” contains more details on the
econometric results and can be found at www.iata.org/economics.

• Own price elasticity is a measure used to capture the
sensitivity of consumers demand for a good or service
in response to changes in the price of that particular
good or service. Goods with elasticities less than one
in absolute value are inelastic or price insensitive.
Goods with elasticities greater than one in absolute
value are elastic or price sensitive.
• Cross price elasticity measures the interaction or the
sensitivity of demand for a particular good to changes
in the price of another good. When the cross price
elasticity is positive, the two goods are substitutes,
when it is negative the goods are complementary.
• Income elasticity measures the sensitivity of demand
for a good to changes in individual or aggregate
income levels.
Air Travel Demand Elasticities
The elasticity of air travel demand varies according to the
coverage and location of the market in which prices are
changed and the importance of the air travel price within
the overall cost of travel. The appropriate elasticity to use
will depend on the type of question being asked. What is
the price that is being changed (e.g. an individual airline
ticket price or prices within the market as a whole)? What
is the unit of demand that is being assessed (e.g. demand
for an individual airline or demand for total air travel)?
Examining the traffic impact of a price increase on a given
route requires a different elasticity than when examining
the impact of an across-the-board price increase on all
routes in a country or region.
There often appears to be some confusion in policy
discussions about the sensitivity of airline passengers to
the price of travel. This has increased as the industry has
changed, with the Internet increasing price transparency,
deregulated markets and no frill carriers increasing
competition and corporate travel buyers becoming more
price sensitive. In particular, there is an apparent paradox
whereby:
• Passengers are becoming increasingly sensitive
to price, led by the boom in low cost travel, the
transparency brought by the Internet and the intense
competition on deregulated markets.
• But, passengers are also becoming less sensitive to
price, as increasingly lower air travel prices, in real
terms mean that the air travel price itself becomes a
smaller and less important part of the total cost of a
typical journey.
01 - Air Travel Demand 5
There appears to be an inconsistency between the
size of price elasticities estimated for the air transport
industry and those estimated for the overall travel and
tourism industry. But there are two main explanations
for this. Firstly, as the air travel component of the
journey can be relatively easily substituted between
airlines, routes, modes, etc, the price elasticity for the
air travel price can be much higher than suggested by
the price elasticity of the overall journey cost. Secondly,
passengers (especially for short leisure journeys) can
use a “two-stage” decision-making process, selecting a
flight destination based on the level of air travel price
offered and then considering the other costs associated
with the journey.
The appropriate value of a demand elasticity will vary in
accordance to the context in which they are considered.
For air transport there are five main levels (for the scope
of the market) for which demand elasticities can be
estimated:
• Price Class Level. This the most disaggregate level,
where passengers make a choice between different
price classes (e.g. first class, business class, economy
class) on individual airlines.
• Airline / Air Carrier Level. This reflects the overall
demand curve facing each airline on a particular route.
• Route / Market Level. At the route or market level
(e.g. London Heathrow–Paris CDG or London–Paris),
travellers faced with a price increase on all carriers
serving a route (e.g. due to an increase in airport fees
and charges), and have fewer options for substitution.
• National Level. At the national level, travel prices are
increased on all routes to and from a particular country
(e.g. due to a higher national departure tax), giving
travellers fewer options for avoiding the price increase.
• Supra-National Level. This represents a change in
travel prices that occurs at a regional level across
several countries (e.g. an aviation tax imposed on all
member states of the European Union). In this case,
the options for avoiding the price increase are even
further reduced.
In each of the five levels of aggregation, different
cross-price elasticities exist, reflecting the availability of
substitute options. The own price elasticity at one level of
aggregation can reflect both the own price and cross price
elasticities at other levels of aggregation. The interaction
between these effects adds significant complexity to the
analysis, requiring clarity on which own price and cross
price elasticities were measured and controlled for. For
example, an analysis of route-level elasticities which does
not control for route substitution effects may be more
appropriate for a national-level elasticity.
The evidence and discussion provided in this report
focuses on the appropriate elasticities for the route,
national and supra-national level of aggregation.
Extensive Review
of Previous Studies
InterVISTAS Consulting reviewed the available literature
on demand elasticities. The review of previous studies
helps to provide a greater understanding of air travel price
elasticities and provides important insights for the new
econometric analysis. The different studies produced a
wide range of air travel price elasticity estimates, varying
in accordance with the markets analysed, the time period
assessed, the methodology used and the available data.
Even within some particular studies, a range of elasticities
are estimated for different markets.
Nevertheless, the previous studies do show a number of
consistent themes. All of the studies reviewed found that
there was a significant demand response to changes in
air travel prices. This indicates that any policy action that
results in higher air travel prices (e.g. passenger taxes,
increased landing fees) will result in a decline in demand.
Critically, however, the extent of that decline will depend
on a number of factors:
• Business vs. Leisure Passengers. In general, all else
being equal, business travellers are less sensitive to
price changes (less elastic) than leisure travellers.
Business travellers generally have less flexibility to
postpone or cancel their travel than leisure travellers.
• Short-Haul vs. Long-Haul Travel. Price elasticities on
short-haul routes were generally higher than on long-
haul routes. In part, this reflects the opportunity for
inter-modal substitution on short-haul routes.
• Airline vs. Market vs. National Elasticities. Some of
the studies supported the concept that the demand
elasticity faced by an individual airline is higher than
that faced by the whole market.
• Income Elasticities. Including income as an explanatory
variable of demand isolates the effects of a shift along
the demand curve (caused by a change in air travel
price) from the effect of a shift of the whole demand
curve (caused by a change in incomes or GDP).
The studies including the income term all produced
positive income elasticities, with air travel increasing at
a higher rate than income growth.
Data Sources
The new econometric analysis undertaken by InterVISTAS
Consulting used three different datasets:
• US Department of Transport database 1B (DB1B).
DB1B provides data on the US domestic aviation
market. Traffic figures reflect the actual number of
passengers on a particular route, while average price
reflects the estimated average one-way travel price
paid (in USD).
• IATA’s Passenger Intelligence Service (PaxIS)
database. This database captures market data
through IATA’s Billing and Settlement Plan (BSP). It
provides traffic and travel price estimates for airport-
pair routes around the world (e.g. JFK-LHR, CDG-
FRA). However, data is only available from 2005
onwards.
• UK International Passenger Survey (IPS). The IPS
is a survey of passengers entering or leaving the UK by
air, sea or the Channel Tunnel. This report exclusively
used outbound to Western Europe leisure air passenger
traffic data from the IPS. Traffic figures reflect the
estimated number of passengers on a particular
airport-pair route, while average travel price reflects the
estimated average price paid (in GBP).
ECONOMETRIC RESULTS
The new econometric analysis is comprehensive, based
on over 500 regression models. Building on the previous
studies, the new econometric analysis develops a set of
in-depth guidelines, and guideline elasticities, that can
be applied to the analysis of different air markets. Base
elasticity estimates are developed for the different levels
of aggregation (route, national and supra-national level).
Multiplicative estimates were then developed to adjust
the elasticities to reflect specific geographical markets.
i) Level of Aggregation
In summary, the econometric results found that at the
route level (where competition between airlines or city-
pair markets is high) the sensitivity of demand to price
is very high. However, at the national or regional level,
air travel is relatively price insensitive. The results support
demand elasticities of:

• Route Level: -1.4
• National Level: -0.8
• Supra-National Level: -0.6
Route Level. The review of previous research found route
level elasticities ranging from -1.2 to -1.5. Regressions
using the US DB1A data, which allows the use of route
dummies and variables to capture the price of route
substitutes, produced a similar air travel price elasticity
of -1.4. This elasticity estimate is applicable to a situation
where the price of an individual route changes (e.g.
higher airport charges at Paris CDG raising the price of
travel from London and diverting leisure traffic to another
destination, such as Frankfurt). Using distance as an
instrument variable within the 2SLS (Two Stage Least
Squares) statistical model produces results that further
support this elasticity, though there still is some concern
over the use of distance in this way due to its perceived
exogenous influence on demand.
National Level. Estimates of national elasticities using all
three datasets found that, without the route substitution
term, elasticities fell to around -0.8. This inelastic result
was found over a range of model specifications which
excluded route dummies. The national level elasticity
applies to a situation such as the doubling of a national
passenger departure tax, affecting all departing routes
equally but leaving the cost of travel from elsewhere
unchanged. Its value reflects a combination of the route
own price elasticities with cross price elasticities, when
all national routes have prices which vary in the same
way. The inelastic result is consistent with observations
that part of the price elasticity observed from low cost
carriers (LCCs) involves substitution from other routes.
When this is controlled for, LCCs have a lower level of
market stimulation, consistent with less elastic national
elasticities.
Supra-National Level. At the supra-national level
(e.g. the European Union) estimates show an even less
elastic air travel price elasticity of -0.6. This is because
as the number of routes covered expands the number of
choices for passengers to avoid any travel price increase
diminishes. There is less opportunity for traffic to be
diverted.
ii) Short-Haul vs. Long-Haul
• The review of previous research found consistent
results showing that air travel price elasticities on
short-haul routes were higher than on long-haul
routes. This largely reflects the greater opportunity
for inter-modal substitution on short haul routes
01 - Air Travel Demand 7
(e.g. travellers can switch to rail or car in response
to air travel price increases). While the geographical
breakdowns outlined in the next section capture some
variation by length of haul, there is still considerable
variation within each market. In particular, very short-
haul flights (approximately less than 1 hour flight time)
are subject to greater competition from other modes.
• On this basis an elasticity multiplier of 1.1 is used
to adjust air travel price elasticities for short-haul
markets. This does not apply to the analysis of trans-
Atlantic or trans-Pacific markets, which are entirely
long-haul, with virtually no opportunity for modal
substitution.
iii) Geographic Market Analysis
The econometric analysis of the IATA PaxIS Plus data
found statistically significant differences between
different geographic air travel markets. The estimated
elasticity multipliers for each market, along with the
reasons for why it is needed, are:
• Intra North America. This is our reference point
with an elasticity multiplier of 1. The market is well
established with relatively high levels of capacity and
traffic. Prices tend to be low, while distances are short
to medium haul.
• Intra Europe. Traffic in this region is estimated to be
more elastic, with an elasticity multiplier of 1.4. Intra
European routes typically have shorter average travel
distances, strong competition from other transport
modes and the use of very low prices in several
markets. The high market share of charter airlines is
being eroded by very low fare LCCs.
• Intra Asia. Moderately more inelastic estimates were
found in this region, with an elasticity multiplier of
0.95. LCCs are now emerging in Asia but average
distances are longer, and the key middle class is still
relatively small in many markets in this region.
• Intra Sub-Saharan Africa. This region is estimated to
have a relatively inelastic demand compared to North
America, with an elasticity multiplier of 0.6. African
economies have a much smaller middle class. Travel
is concentrated among higher income individuals who
are less price-sensitive.
• Intra South America. This region is estimated to be
at the more elastic end of the scale, with an elasticity
multiplier of 1.25. There is an emerging middle class
making the region more price elastic plus LCCs are
emerging in Brazil, Chile and Mexico.
• Trans Atlantic (North America – Europe). A high
price elasticity was found for this market, with an
elasticity multiplier of 1.2. This market has long been
developed by low fare charter airlines. Price is likely
more important than frequency in this market than in
US domestic markets
• Trans Pacific (North America – Asia). By contrast,
markets across the Pacific are estimated to have a
much less elastic response, with an elasticity multiplier
of 0.6. There are no charter services and there remain
markets with less liberal pricing regulation. There are
early signs of long-haul LCCs emerging but at present
this market shows much less sensitivity to travel price
than the US domestic market or the trans Atlantic
market.
• Europe-Asia. This market is estimated to be slightly
less price sensitive, with an elasticity multiplier of
0.9. This result is in contrast to the results found in
the respective intra markets of Europe and Asia, and
provides further evidence for lower elasticities on long-
haul and intercontinental air transportation.
Applying the Elasticity Estimates
and Multipliers
Table 1 provides a guideline for the estimated price
demand elasticity by level of aggregation and by
region. It multiplies the estimate for the relevant level of
aggregation by the relevant short-haul and geographic
elasticity multipliers.
By way of illustration, elasticities for different situations
can be developed by selecting the relevant base price
elasticity and applying the relevant multipliers. For
example:
• To examine the impact of an EU-wide aviation tax on
short-haul markets, the elasticity would be developed
as follows:
- Base multiplier: -0.6 (supra-national)
- Geographic market: 1.4 (Intra Europe)
- Short-haul adjustor: 1.1
The price elasticity would then be calculated as:
-0.6 x 1.4 x 1.1 = -0.92
• To examine the impact of a UK tax on aviation
on Trans Atlantic traffic, the elasticity should be
developed as follows:
- Base multiplier: -0.8 (national)
- Geographic market: 1.2 (Trans Atlantic)
The price elasticity would then be calculated as:
-0.8 x 1.2 = -0.96
• To examine the impact of an increase in airport landing
fees on a particular short-haul route in Asia, the
elasticity should be developed as follows:
- Base multiplier: -1.4 (route)
- Geographic market: 0.95 (Intra Asia)
- Short-haul adjustor: 1.1
The price elasticity would then be calculated as:
-1.4 x 0.95 x 1.1 = -1.46

Table 1: Estimated Price Elasticities of Passenger Demand

Route/Market level National level Supra-national level

Short-haul Long-haul Short-haul Long-haul Short-haul Long-haul

Intra N America -1.5 -1.4 -0.9 -0.8 -0.7 -0.6
Intra Europe -2.0 -2.0 -1.2 -1.1 -0.9 -0.8
Intra Asia -1.5 -1.3 -0.8 -0.8 -0.6 -0.6
Intra Sub- -0.9 -0.8 -0.5 -0.5 -0.4 -0.4
Saharan Africa
Intra S America -1.9 -1.8 -1.1 -1.0 -0.8 -0.8
Trans-Atlantic -1.9 -1.7 -1.1 -1.0 -0.8 -0.7
Trans-Pacific -0.9 -0.8 -0.5 -0.5 -0.4 -0.4
Europe-Asia -1.4 -1.3 -0.8 -0.7 -0.6 -0.5
 01 - Air Travel Demand 9

Income Elasticities • There is some evidence that income elasticities

The main focus of the research was on price elasticities.
Nevertheless, the analysis also considered the sensitivity
of demand to changes in incomes. The econometric
research and review of previous estimates found that air
transport income elasticities were consistently positive and
greater than one. This suggests that as households and
individuals get more prosperous, they are likely to devote
an increasing share of their incomes to discretionary
spending such as air travel.
The statistical evidence suggests:
• Developed country travel markets have base income
elasticities for short-haul routes of around 1.5. At the
national level, this declines to an estimated income
elasticity of 1.3.
• US travel markets have slightly higher income
elasticities with air travel perhaps less budget-oriented
than in other developed economies. Using the DB1A
data suggests short-haul route income elasticities of
1.8 at the route level and 1.6 at the national level.
decline as countries become richer and markets
mature. Developing countries typically have a greater
responsiveness, with an estimated short-haul income
elasticity of around 2.0 at the route level and 1.8 at the
national level.
• There is also evidence that long-haul journeys are
seen by passengers as different, more desirable, to the
more commoditised short-haul markets, and so income
elasticities are higher the longer the distance. This
suggests that middle to lower income individuals are
more likely to travel on short to medium haul routes,
with higher incomes leading to a higher frequency of
long haul travel.
The income elasticity results are based on information
from the review of previous studies and results from the
new econometric research. Table 2 outlines the estimated
income elasticities for different markets at the route and
at the national level.

Table 2: Estimated income elasticities of passenger demand

Route / Market Short-haul Medium-haul Long-haul Very long-haul
level
US 1.8 1.9 2.0 2.2
Developed 1.5 1.6 1.7 2.4
economies
Developing 2.0 2.0 2.2 2.7
economies
National level Short-haul Medium-haul Long-haul Very long-haul
US 1.6 1.7 1.8 2.0

Developed 1.3 1.4 1.5 2.2

economies
Developing 1.8 1.8 2.0 2.5
economies
If passengers are relatively insensitive to air travel prices
at a national aggregate market level, and even less so at
a supra-national level, this strongly suggests that falling
real air travel prices have not been the main driver of air
travel growth2. Falling real air travel prices are important
in passengers switching from one airline to another,
and from one destination to another, but are much less
important in driving aggregate national-level air travel or
tourism growth.
The growth of incomes, often proxied by GDP, has been
found to be the fundamental driver of the demand for
air travel. During the past twenty years global passenger
traffic has expanded at an average annual growth rate of
5.1%, while global GDP grew by an average annual rate
of 3.7% over the same period. That implies an average
income elasticity of 1.4, similar to the average estimated
above for developed economies. The implication is that
economic growth can explain most of the expansion
in air travel seen in the past twenty years. The fall in
real air travel prices has played a part, but mostly in
diverting travel between airlines and markets rather than
significantly boosting overall travel volumes. In addition,
economic growth is now increasingly being driven by
developing economies, where income elasticities are
higher. Therefore, the underlying drivers for overall
air travel growth are likely to remain strong for the
foreseeable future.
2
This conclusion was reached in a recent study of the UK market (UK CAA, 2006, No frills carriers; revolution or evolution). It concludes that
“despite the spectacular growth of no-frills carriers in the UK, and the perceptions about the impact they have had on travel habits, there has
been little change in long-term aggregate passenger traffic growth rates”.
3
Building a Greener Future (2007) IATA.
Inbound vs Outbound Price
Elasticities
One further adjustment that may need to be applied to the
price elasticity estimates in table 1 is for the case when
the passenger flow of concern is inbound or outbound,
not the total or average impact. This will be of particular
importance when considering the impact on inbound
tourism of, for example, a national passenger tax. It
also matters when considering the diversion of inbound
passengers and consequent reduction of effectiveness
of a national or regional environmental tax.
The price elasticity estimates in table 1 are all averages
of outbound and inbound passengers. Most databases
of passenger numbers and fares do not distinguish
between domestic residents travelling overseas then
returning, and overseas residents visiting and then
returning home. However, their sensitivity to travel
prices including taxes will differ.
These estimates will be verified by future research.
Meanwhile a reasonable rule-of-thumb multiplier to
adjust the price elasticities in table 1 is as follows:
Inbound travel by overseas residents = -1.3/-1.0
= 1.3 * table 1 price elasticity
Outbound travel by domestic residents = -0.8/-1.0
= 0.8 * table 1 price elasticity

Policy Implications
The correct elasticity value to use in analysing an air
transport policy decision depends on the type of question
being asked. The impact on demand of higher travel
costs on a given route due to a rise in airport landing
charges requires a different (higher) elasticity than when
examining the traffic impact of a wider travel cost increase
due to a passenger tax on all routes in a country.
Air transport policy decisions run the risk of being
ineffective, or even counter-productive, if the correct
demand elasticity is not used. For example:
• A revenue-raising policy to raise the price of travel
on a route (e.g. higher airport charges) will reduce
passenger numbers more than expected if the price
elasticity of demand is underestimated. A price elastic
response to air travel price increases at the route level
means that demand falls at a proportionately higher
rate than the increase in price.
• A national passenger tax may damage inbound
tourism more than expected if policy-makers do
not take into account the greater price elasticity of
overseas residents visiting the country, who have
a choice of destinations, compared to outbound
domestic residents who can either pay the tax or
not travel.
• An environmental policy to raise the price of travel
(e.g. a national aviation tax) on a national or supra-
national basis will be ineffective if the price elasticity
of outbound travel is low, as found. A price inelastic
response at the national or supra-national level
means that the impact in terms of reducing demand
will be proportionately less than the increase in price.
The greater price sensitivity of inbound overseas
residents will result in a diversion to other destinations,
a “leakage of carbon”, and thus a reduction in
environmental effectiveness.
01 - Air Travel Demand 11
The focus of existing policy to reduce CO2 emissions from
air travel has been on trying to manage air travel demand
by raising the cost of travel for passengers. The results
contained in this report show that such policies are likely
to fail. Decoupling emissions from travel growth needs to
focus not on demand management but on mechanisms
to bring about emissions reduction measures from
technology, infrastructure and operations.
IATA’s 4-Pillar Climate Strategy3 , which was endorsed
by the Assembly of the International Civil Aviation
Organisation in 2007, focuses action on emission
reduction measures from technology, infrastructure,
operations and those brought about by well designed
economic instruments.
Effectively decoupling emissions from air travel growth
will require policy-makers and the industry to look beyond
simple economic instruments:
• Technological progress will require collaboration
across the value chain and across countries.
• Governments will need to play a role in funding
fundamental research.
• Political will is perhaps one of the most important
mechanisms for delivering emissions reductions from
infrastructure improvements.
• The lack of implementation of a Single European
Sky is one glaring omission in policy action to reduce
emissions from air travel.
IATA is actively promoting collaborative efforts on
technology and is lobbying hard for governments to
improve infrastructure. For operations, there is a major
initiative to spread best practices. More needs to be done
about the challenges of climate change, but the airline
industry is already stepping up efforts with a bold vision of
zero emissions and an important target of carbon-neutral
growth. The key lesson for both policy-makers and the
industry is to look beyond simple economic instruments
for mechanisms to bring about an effective reduction in
emissions from air travel.
02 Report Outline

Air transport is an integral part of the global

economy. It is essential to understand the
sensitivity of air transport demand to policy
and economic decisions, and to ensure
that these decisions are made on a more
effective and appropriate basis.

This report discusses the key findings from extensive
research undertaken on behalf of IATA by InterVISTAS
Consulting Inc. to estimate air travel demand elasticities
applicable to a wide range of air transport markets.
It provides important new evidence for estimating
elasticities in different locations and scenarios, based on
access to comprehensive air travel databases. It builds
upon previous academic research into air travel demand
elasticities.
The report is structured as follows:
What are Demand Elasticities?
Chapter 3 provides definitions for different categories
of demand elasticities and discusses how each can
be interpreted. It outlines three key concepts: price
elasticity of demand, cross-price elasticity of demand
and income elasticity of demand. It also discusses key
factors that influence both the demand for air transport
and the sensitivity of this demand to changes in prices
and incomes.
How can this be applied to air travel demand?
Chapter 4 discusses the different types of demand
elasticity that can be estimated for air travel. It discusses
how the relevant demand elasticity can change in relation
to the market size and its geographical location.
02 - Air Travel Demand 13
Previous estimates
Chapter 5 summarises the key findings from the review
undertaken by InterVISTAS Consulting Inc. of previous
academic studies that have estimated air travel demand
elasticities. It outlines the wide range of estimates that
have been produced, as well as the common themes
between the majority of the studies.
New evidence for air travel demand elasticities
Chapter 6 outlines the key findings from a comprehensive
econometric analysis of the data from three key air travel
data sources. The results from this analysis provide
important new evidence of the relevant demand elasticity
in different markets.
What does this mean for air transport policymakers?
Chapter 7 discusses how this new evidence can be applied
to air transport policy decisions. It provides guidelines
for the application of air travel demand elasticities for
different types of decisions. It helps to ensure that policy
decisions are made on the basis of appropriate and
reliable estimates of their impact on demand.
Chapter 8 provides a summary and conclusions.
03 The Definition

of Demand
Elasticities
Elasticity measures the response of one
economic variable (e.g. the quantity
demanded) to a change in another economic
variable (e.g. price). It provides key insight
into the proportional impact of different
economic actions and policy decisions.

Demand elasticities measure the change in the quantity
demanded of a particular good or service as a result of
changes to other economic variables, such as its own
price, the price of competing or complementary goods and
services, income levels, taxes, etc. This report estimates
the demand elasticity of air travel under various scenarios
and locations. It highlights three main types of demand
elasticity: own price elasticity, cross price elasticity and
income elasticity.
i) Price Elasticity of Demand
Price elasticity is a measure used to capture the sensitivity
of consumer demand for a good or service in response to
changes in the price of that particular good or service.
The price elasticity is defined as:
Price Elasticity =
% Change in Quantity Demanded negatively affect both its own demand and the demand of
% Change in Price
The quantity demanded generally decreases when the
price increases, so this ratio is usually expected to be
negative. For example, if a 10% increase in the price of
good A results in a 6% fall in the quantity demanded of
that good, its own price elasticity is -0.6. By contrast, if a
10% fall in the price of good B leads to a 12% increase in
the quantity demanded of good B, its own price elasticity
is -1.2.
Goods with elasticities less than one in absolute value
are commonly referred to as having inelastic or price
insensitive demand. In other words, the proportional
change in quantity demanded will be less than the
proportional change in price. In this situation, increasing
the price will increase the revenue received by the
producer of the good, since the revenue lost by the
decrease in quantity is less than the revenue gained from
the higher price.
Goods with elasticities greater than one in absolute
value are referred to as having elastic or price sensitive
demand. In other words, the proportional change in
quantity demanded will be greater than the proportional
change in price. A price increase will result in a revenue
decrease to the producer since the revenue lost from
the resulting decrease in quantity sold is more than the
revenue gained from the price increase.
03 - Air Travel Demand 15
ii) Cross Price Elasticity of Demand
The cross price elasticity measures the interaction in
demand between different goods or services. It measures
the sensitivity of demand for a particular good to changes
in the price of another good:
Cross Price Elasticity =
% Change in Quantity of Good A Demanded
% Change in Price of Good B
When the cross price elasticity is positive, the two goods
are substitutes (e.g. Coca-Cola and Pepsi). In other words,
an increase in the price of one good will lead consumers
to shift demand towards the relatively cheaper substitute
good. When the cross price elasticity is negative the
goods are complementary goods (e.g. coffee and milk).
In other words, an increase in the price of one good will
goods that are usually bought to accompany it.
iii) Income Elasticity of Demand
The income elasticity measures the sensitivity of demand
for a good to changes in individual or aggregate income
levels:
Income Elasticity =
% Change in Quantity Demanded
% Change in Income
An income elasticity between 0 and +1 indicates a
normal good, where the quantity demanded increases at
the same or a lesser rate than the increase in income. For
example, a good where a 10% increase in income results
in a 0-10% increase in consumption would be considered
a “normal” good.
An income elasticity greater than +1 indicates what
economists call a luxury good, where consumption
increases by a greater proportion than income. For
example, as discretionary incomes rise consumers can
afford to buy higher quality and/or leisure related goods
that were previously beyond their reach. This does not
mean these goods are the exclusive preserve of the rich,
but that as living standards rise consumers value buying
these goods the most. It is a measure of a highly valued
good in consumer welfare terms.
A negative income elasticity indicates an inferior good,
where the quantity demanded decreases as aggregate
incomes increase. In other words, with higher incomes,
consumers buy less of an inferior good and substitute
it with better quality goods (e.g. buying branded goods
rather than supermarket own-brands).

Key factors influencing demand elasticities

Demand elasticities can be influenced by several factors.
The individual characteristics of a good or service will
have an impact, but there are also a number of general
factors that will typically affect the sensitivity of demand:

• Availability of substitutes. The elasticity is typically

higher the greater the number of available substitutes,
as consumers can easily switch between different
products.

• Degree of necessity. Luxury or highly valued products

typically have a higher elasticity. Some products that
are initially a luxury are habit forming and can become
“necessities” to some consumers. Bread has a low
elasticity as it is considered a necessity, as does
tobacco because it is habit forming.

• Proportion of the budget consumed by the item.

Products that consume a large portion of the
consumer’s budget tend to have greater elasticity.

• Time period considered. Elasticities tend to be greater

over the long run because consumers have more time
to adjust their behaviour.

• Whether the good or service is demanded as an input

into a final product or whether it is the final product.
If the good or service is an input into a final product
then the price elasticity for that good or service will
depend on the price elasticity of the final product, its
cost share in the production costs, and the availability
of substitutes for that good or service.

Each of these general factors, along with the specific

characteristics of the product, will interact to determine
its overall responsiveness of demand to changes in prices
and incomes.
04 Key Types of Air

Travel Demand
Elasticities
The elasticity of air travel demand varies
according to the coverage and location of
the market in which prices are changed
and the importance of the air travel price
within the overall cost of travel. The
appropriate elasticity to use will change
according to the precise impact that is
being analysed.
The previous chapter provided definitions for the different types of demand elasticity.
Yet, when using this methodology to estimate the demand elasticity of air travel it is
important to be clear about the precise question that is being asked. What is the price
that is being charged (e.g. an individual airline ticket price or prices within the market
as a whole)? What is the unit of demand that is being assessed (e.g. demand for an
individual airline or demand for total air travel)? Estimating an appropriate demand
elasticity requires a clear definition of what is being studied.

Air Travel Prices
and Total Travel Costs
There often appears to be some confusion in policy
discussions about the sensitivity of airline passengers
to the cost of travel. Some researchers have questioned
whether estimated air travel price elasticities are
consistent with changes in the total cost of travel (which
may also include hotel, ground transport to/from the
airport, food, entertainment, etc). In particular, there is an
apparent paradox whereby:
• Passengers are becoming increasingly sensitive
to price, led by the boom in low cost travel, the
transparency brought by the Internet and the intense
competition on deregulated markets.
• But, passengers are also becoming less sensitive to
price, as increasingly lower air travel prices, in real
terms, mean that the air travel price itself becomes a
smaller and less important part of the total cost of a
typical journey.
The proportion of total spending on an overseas visit
by air will vary by country. In particular, air travel prices
are likely to represent a higher proportion of travel
spending in low income countries, especially where air
travel markets have not been liberalised. However, for
the bulk of air travel in liberalised OECD markets the
air travel price typically represents around 25% of the
total travel costs associated with leisure travel (though
the exact percentage varies depending on the length
and type of travel).4
Therefore, assuming an air travel price elasticity of -1.5, a
10% increase in the cost of the air travel price will reduce
demand for travel by 15% (if the demand for air travel
declines by 15%, it is assumed that the demand for the
whole travel package will also decline by 15%). However,
a 10% increase in the air travel price represents a 2.5%
increase in the total cost of travel. This implies that the
price elasticity with respect to total travel costs is -6.0
(-15% / 2.5%), an extremely high elasticity and one
which is not matched by the much lower elasticities
estimated by previous quantitative research of tourism
demand elasticities.
4
For example, the International Passenger Survey by the UK Office of National Statistics estimates that for UK residents travelling to Europe
by air, the travel price represented 27% of the total journey cost in 2004. This proportion has declined in the last ten years, led by the growth of
no-frills LCC airlines.
04 - Air Travel Demand 19
There appears to be an inconsistency between the size of
price elasticities estimated for the air transport industry
and those estimated for the overall travel and tourism
industry. Yet everyone in the travel and tourism industries
knows they are dealing with very price sensitive customers,
and that changing prices does produce a large demand
response. There are two main explanations:
• Substitution of components within an overall
package. In situations where one component of
a package can be substituted for an adequate
alternative then the price elasticity for that component
can be much higher than suggested by the price
elasticity of the overall package. For example, changes
in an air travel price could result in the passenger
changing to a different airline, route or another
transport mode while still undertaking a similar journey.
Therefore, the elasticity for the overall journey cannot
be inferred from the air travel price elasticity and must
instead be estimated on a separate basis.
• A “two-stage” decision-making process. Travellers
are induced to select a destination based on the level
of air travel price offered, and having booked the
flight then consider the other costs associated with
the travel (e.g. booking a low-fare air ticket and then
making a separate decision on hotels, etc). In this
case, the overall decision to travel is more sensitive to
changes in the initial air travel price.
Therefore, passengers can be relatively more sensitive
to the cost of the air travel price, even though it is only
one component within the overall cost of travel. Air travel
itself is a derived demand, based on the demand for
passengers to travel to another location for business or
leisure purposes. The other components of the journey
cost are derived from the decision to travel and are
essentially complementary goods to air travel (i.e. they
have a cross-price elasticity to air travel prices of less
than zero).
Level of Aggregation
The appropriate value of a demand elasticity will vary in
accordance to the context in which they are considered. In
particular, the scope of the price change and the demand
impact being assessed will have a key influence on its
value, with demand typically being more sensitive to price
when a greater amount of substitutes are available.
For air transport there are five main levels (for the scope
of the market) for which demand elasticities can be
estimated:
• Price Class Level. This is the most disaggregate level,
where passengers make a choice between different
price classes (e.g. first class, business class, economy
class) on individual airlines. At this level, the elasticities
are arguably highest, with passengers easily able to
switch between price-class levels and airlines, while
also (in some cases) having the option to use another
mode of travel or simply to choose to not travel (i.e.
other activities act as a substitute for air travel).
• Airline / Air Carrier Level. This reflects the overall
demand curve facing each airline on a particular route.
Where there are a number of airlines operating on a
route , the demand elasticity faced by each airline is
likely to be fairly high. If an airline increases its price
unilaterally, it is likely to lose passengers to other
airlines operating on that route.5
• Route / Market Level. At the route or market level
(e.g. London Heathrow–Paris CDG or London-Paris),
the elasticity response is expected to be lower than at
the price class or carrier level. Travellers faced with a
travel price increase on all carriers serving a route (e.g.
due to an increase in airport fees and charges), have
fewer options for substitution. However, they can still
choose to travel on an alternative route, while also (in
some cases) having the option to use another mode of
travel or simply choose to not travel.
• National Level. At the national level, travel price
elasticities are expected to be lower, as travellers
have fewer options for avoiding the price increase. For
example, if a national government imposed a new or
increased tax on aviation, travellers could only avoid
this increase by travelling elsewhere, using another
mode (which may not always be possible), or choosing
not to travel. For example, if the UK government
imposed an increased tax on aviation departures, UK
residents travelling to mainland Europe could respond
by travelling by Eurostar or by ferry, or choose not to
travel. Similarly, travellers in France could respond by
travelling to the UK by another mode or by switching
their destination to another country, such as Germany
or Spain.
• Supra-National Level. This represents a change in
prices that occurs at a regional level across several
countries. For example, an aviation tax imposed on
all member states of the European Union. In this
case, the elasticity is expected to be even lower, as
the options for avoiding the price increase are even
further reduced.
5
Even in a situation where an air carrier has a monopoly on a route, it may still face a fairly high demand elasticity as connecting options can
also act as a substitute (e.g. passengers could travel from London to Delhi via Paris or Dubai rather than direct).
6
See Annex A for more details.
The evidence and discussion provided in this report focus
on the appropriate elasticities for the route, national and
supra-national level of aggregation.
The Interaction between Own-Price
and Cross-Price Elasticites
In each of the five levels of aggregation, different
cross-price elasticities exist, reflecting the availability of
substitute options. For example:
• At the price class level, an increase in the full economy
price could increase the demand for both business
class tickets and discount tickets.
• At the airline level, a unilateral increase in the travel
price of one particular airline on a route can increase
the demand for other carriers on the route (and the
demand for connecting alternatives).
• At the route level, an increase in the price of travel
from London Heathrow to Paris CDG can increase the
demand for travel on London Gatwick to Paris CDG or
London Heathrow to Paris Orly.
• At the national level, an increase in the price of air
travel to/from a given country may increase demand
for air travel to/from other countries.
• At the supra-national level, an increase in the price
of air travel to/from a particular region may increase
demand for air travel to/from other regions (e.g.
an increase in the cost of air travel to the EU may
increase demand for air travel to the US).
• At all levels of aggregation, there may exist cross
elasticity effects with other modes of transport. An
increase in the price of air travel may increase demand
for ground transportation and vice versa.
• There may also be cross elasticity effects between
air travel and other leisure or consumption activities.
In some cases it may not exist at all (e.g. there is
generally no substitute for air travel on long-haul
routes).
The own price elasticity at one level of aggregation can
reflect both the own price and cross price elasticities
at other levels of aggregation. For example, the price
elasticity at the route level is a function of the own
price and cross price elasticities at the price class
and carrier levels of aggregation6 . The interaction
between these effects adds significant complexity to
the analysis, requiring clarity on which own price and
cross price elasticity were measured and controlled for.
For example, an analysis of route-level elasticities which
does not control for route substitution effects may be
more appropriate for a national-level elasticity.
05 Previous

Estimates
of Air Travel
Demand
Elasticities
The results from previous studies of air travel
demand elasticities vary in accordance
with the type of elasticity that is estimated.
Nevertheless, there are several key themes
that can be identified that provide insights
into the sensitivity of air travel demand.

There is a substantial amount of evidence on air travel
demand elasticities available from previous studies.
However, these studies have also produced a wide variety
of results, reflecting large differences in the nature and
scope of the elasticities that have been looked at. As
part of its research, InterVISTAS Consulting reviewed the
available literature on demand elasticities. This chapter
summarises the key themes that can be identified across
the different studies.
Overview of Previous Studies
The review of previous studies helps to provide a greater
understanding of air travel price elasticities and provides
important insights for the new econometric analysis by
InterVISTAS Consulting (discussed in the next chapter).
The review looked at several academic and government
commissioned studies . The different studies7 produced a
wide range of air travel price elasticity estimates, varying
in accordance with the markets analysed, the time period
assessed, the methodology used and the available data.
Even within some particular studies, a range of elasticities
are estimated for different markets.
For example, a commonly referenced study by Gillen,
Morrison and Stewart8 found demand elasticities ranging
from -0.1 to -1.7, depending on the relevant market. It
identified various elasticity estimates for several distinct
markets for air travel, such as:
Long-Haul Price Elasticities
• International Business: -0.3
• Domestic Business: -1.1
• International Leisure: -1.0
• Domestic Leisure: -1.1
Short-Haul Price Elasticities
• Business: -0.7
• Leisure: -1.5
Key Themes
A review of the existing literature of previous studies on air
travel price elasticities shows a number of consistent themes.
All of the studies reviewed, spanning a period of over 25
years, found that there was a significant demand response
to changes in air travel prices. The consistency of this result
strongly indicates that any policy action that results in higher
prices (e.g. passenger taxes, increased landing fees) will
result in a decline in demand. However, critically, the extent
of that decline will depend on a number of factors:
7
See Annex B for a list of the studies that were reviewed.
8
Gillen, Morrison and Stewart (2002), Air Travel Demand Elasticities: Concepts, Issues and Measurements.
05 - Air Travel Demand 23
• Business Versus Leisure Passengers. In general,
all else being equal, business travellers are less
sensitive to travel price changes (less elastic) than
leisure travellers. Intuitively, this result is plausible;
business travellers generally have less flexibility to
postpone or cancel their travel than leisure travellers.
Nevertheless, the studies do show that even business
travel will decline in the face of price increases, albeit
not to the same extent as leisure travel.
• Short-Haul Versus Long-Haul Travel. Another
consistent result was that air travel price elasticities
on short-haul routes were generally higher than on
long-haul routes. In part, this reflects the opportunity
for inter-modal substitution on short-haul routes (e.g.
travellers can switch to rail or car in response to air
travel price increases).
• Airline Vs Market Vs National Elasticities. Some of
the studies supported the concept that the demand
elasticity faced by an individual airline is higher than
that faced by the whole market. For example, Oum,
Zhang, and Zhang (1993) estimated firm-specific
elasticities in the U.S. and estimated values ranging
from -1.24 to -2.34, while studies estimating market or
route elasticities ranged from -0.6 to -1.6. In contrast,
Alperovich and Machnes (1994) and Njegovan (2006)
used national-level measures of air travel in Israel and
the UK respectively and produced even lower elasticity
values (-0.27 and -0.7, respectively).
• Income Elasticities. Many of the studies also
included income as an explanatory variable of air travel
demand. This will isolate the effects of a shift along
the demand curve (caused by a change in air travel
price) from the effect of a shift of the whole demand
curve (caused by a change in incomes or GDP).
The studies including the income term all produced
positive income elasticities, as would be expected
(air travel increases as incomes increase). Virtually all
of these studies estimated income elasticities above
one, generally between +1 and +2. This indicates air
travel increases at a higher rate than income growth.
This has important implications for policies seeking to
manage air travel demand by raising the price of travel.
06 New Estimates

of Price
and Income
Elasticities
of Air Travel
Demand
New econometric research builds on the
work of previous studies to show that
demand elasticities vary according to the
level of aggregation and the location of
the market. It develops guideline demand
elasticity estimates to use for different
situations.

The literature review highlighted that air travel price
elasticities vary depending on a number of factors such
as location, distance and level of market aggregation.
InterVISTAS Consulting used this guidance to undertake
new econometric analysis using three different datasets.
The new analysis is comprehensive, based on over 500
regression models. Building on the previous research,
the new econometric analysis develops a set of in-depth
guidelines, and guideline elasticities, that can be applied
to the analysis of different air markets, broken down by
geographic market, length of haul and level of aggregation
(route, national and supra-national).
Data Sources
InterVISTAS Consulting used three different databases
for the econometric research:
• US Department of Transport’s database 1B
(DB1B). DB1B provides data on the US domestic
aviation market. It is a very reliable source of data,
representing a 10% sample of origin-destination
passengers and air travel price for each airline on each
city-pair route (e.g. New York-Los Angeles). Quarterly
traffic and price data was taken for the period from
1994 Q1 to 2005 Q4 for the top 1000 city pair routes
(by traffic). Traffic figures reflect the actual number
of passengers on a particular route during the given
quarter, while average travel price reflects the estimated
average one-way price paid (in USD).
• IATA’s Passenger Intelligence Service (PaxIS)
database. This database captures market data
through IATA’s Billing and Settlement Plan (BSP) and
uses statistical estimates to address missing direct
sales, low cost carriers, charter flight operators, under-
represented BSP markets, and non-BSP markets. It
provides traffic and price estimates for airport-pair
routes around the world (e.g. JFK-LHR, CDG-FRA).
However, data is only available from 2005 onwards.
• UK International Passenger Survey (IPS). The
IPS is a survey of passengers entering or leaving
the UK by air, sea or the Channel Tunnel. This report
exclusively used outbound to Western Europe leisure
air passenger traffic data from the IPS. Quarterly
traffic and price data was taken for the period from
2003 Q2 to 2006 Q2. Traffic figures reflect the
estimated number of passengers on a particular
airport-pair route during the given quarter, while
average price reflects the estimated average price
paid (in GBP).
9
See Annex C for more details on each type of specification.
06 - Air Travel Demand 25
Model Specifications
The new econometric research tested a number of
different estimation methods and model specifications
to provide explanations of economic phenomena within
each given market. In all models, traffic was the dependent
variable. The different specifications used were9:
• Ordinary Least Squares (OLS). OLS is a method
relating passenger traffic to air travel prices,
income levels and other variables, while minimising
the variance (randomness) of the estimates. The
regression analysis allows the relationship between
traffic and air travel prices to be isolated and
quantified while controlling for other factors that may
impact air travel, such as GDP, population levels, route
distance and seasonality.
• Two-Stage Least Squares (2SLS). 2SLS is often
used to improve the consistency of elasticity estimates
when explanatory variables are believed to be
correlated with the regression model’s error term.
• Autoregressive Distributed Lag (ARDL). An
autoregressive ARDL model uses similar explanatory
variables to the OLS model, but also uses lagged
values of the traffic variable. The inclusion of lagged
values accounts for the slow adjustment of supply (in
the form of capacity) to changes in the explanatory
variables.
Explanatory Variables
The econometric research estimated regression models
that included a variety of explanatory variables to search
for the best fit:
• Average Price. Average air travel price was used to
measure the price of air travel, reflecting average route
prices over the period reported. The average price
variable appears in all model specifications.
• Gross Domestic Product. GDP is used to measure
the effect of income on air travel. GDP estimates
are widely available, providing a variable that can
be consistently defined between regions and over
time. Within the US, GDP estimates are available at
the city pair level. Regression models using the IPS
data set used UK national GDP. Regression analysis
for all other regions used national GDP values,
 converted into US dollars. GDP appears in all model
specifications.
• Population. Population has a direct effect on the size
of a market and may cause a bias in the estimates
if omitted. For example, a large increase in traffic
may reflect a sudden boom in population rather than
other effects. Population was tested in all model
specifications but the best results tended to be at the
city pair level, so it is only included in the US domestic
regression results.
• Route Distance (Trip Length). The use of route
distance is based on its ability to reflect the value of
travel time savings and availability of substitutes. As
distance increases, the viability of other transport
modes as a substitute decreases. The use of route
distance as an instrumental variable in 2SLS requires
that distance be uncorrelated with traffic. This is most
likely in the domestic US market.
• Substitute Goods. The inclusion of a substitute travel
price variable was tested on a subset of routes and
was found to increase price elasticities. Estimates
that exclude a meaningful substitute in the regression
model will produce more inelastic estimates than
a correctly specified model would produce. Route
substitutes can be defined as a different airport
serving the same catchment area (e.g. Chicago-
O’Hare or Chicago-Midway) or a different destination
serving the same purpose (e.g. Las Vegas or Reno).
• Real Exchange Rates.10 In theory, as the foreign
country becomes more expensive (inexpensive),
leisure travellers will travel to the foreign country
less (more). However, the econometric research
was unable to obtain robust estimates using this
variable, possibly due to difficulties in obtaining an
accurate measure of the variable. Therefore, real
exchange rates were excluded from the final model
specifications.
• Time Variables. The use of several different forms
of time variables was explored, but only quarterly
(seasonal) time dummy variables were found to
increase the explanatory power of the model. This
suggests that both travel prices and demand are
inherently seasonal (at least on a quarterly basis).
• Route Dummies. These dummy variables were found
in many cases to increase the explanatory power of
the model, suggesting that some other route-specific
factors are important for demand (e.g. whether or
not non-stop service is available, whether there are
competing carriers operating on non-stop routes,
10
The real exchange rate is defined as the consumer price index (CPI) in the foreign country divided by the CPI in the domestic country divided
by the exchange rate (foreign currency per unit of domestic currency).
whether there is a low cost carrier, what types of
cultural or financial linkages there are between pairs
of cities). The use of route dummy variables controls
for these variables without the need to quantify them.
ECONOMETRIC RESULTS
The new econometric research supports the discussion
from previous chapters that the sensitivity of passengers
to the level of air travel prices depends significantly on the
level of the market being considered and its location. The
results are based on a synthesis of the new econometric
results and the review of previous research. Base
elasticity estimates are developed for the different levels
of aggregation (route, national and supra-national level).
Multiplicative estimates were then developed to adjust
the elasticities to reflect specific geographical markets.
i) Level of Aggregation
In summary, the econometric results found that at the
route level (where competition between airlines or city-
pair markets is high) the sensitivity of demand to price
is very high. However, at the national or regional level,
air travel is relatively price insensitive. The results support
demand elasticities of:
• Route Level: -1.4
• National Level: -0.8
• Supra-National Level: -0.6
Route Level. The review of previous research found route
level elasticities ranging from -1.2 to -1.5. Regressions
using the US DB1A data, which allows the use of route
dummies and variables to capture the price of route
substitutes, produced a similar air travel price elasticity
of -1.4. This elasticity estimate is applicable to a situation
where the price of an individual route changes (e.g.
higher airport charges at Paris CDG raising the price of
travel from London and diverting leisure traffic to another
destination, such as Frankfurt). Using distance as an
instrument variable within the 2SLS model produces
results that further support this elasticity, though there
still is some concern over the use of distance in this way
due to its perceived exogenous influence on demand.
National Level. Estimates of national elasticities using all
three datasets found that, without the route substitution
term, elasticities fell to around -0.8. This inelastic result
was found over a range of model specifications which
excluded route dummies. The national level elasticity
applies to a situation such as the doubling of a national

passenger departure tax, affecting all departing routes
equally but leaving the price of travel from elsewhere
unchanged. Its value reflects a combination of the route’s
own price elasticities with cross price elasticities, when
all national routes have prices which vary in the same
way. The inelastic result is consistent with observations
that part of the price elasticity observed from low cost
carriers (LCCs) involves substitution from other routes.
When this is controlled for, LCCs have a lower level of
market stimulation, consistent with less elastic national
elasticities.
Supra-National Level. At the supra-national level
(e.g. the European Union) estimates show an even less
elastic air travel price elasticity of -0.6. This is because
as the number of routes covered expands, the number of
choices for passengers to avoid any travel price increase
diminishes. There is less opportunity for traffic to be
diverted.
ii) Short-Haul Vs Long-Haul
The review of previous research found consistent results
showing that air travel price elasticities on short-haul
routes were higher than on long-haul routes. This largely
reflects the greater opportunity for inter-modal substitution
on short-haul routes (e.g. travellers can switch to rail or
car in response to air travel price increases). While the
geographical breakdowns outlined in the next section
capture some variation by length of haul, there is still
considerable variation within each market. In particular,
very short-haul flights (approximately less than 1 hour
flight time) are subject to greater competition from other
modes.
On this basis an elasticity multiplier of 1.1 is estimated
and used to adjust air travel price elasticities for short-
haul markets. This does not apply to the analysis of trans
Atlantic or trans Pacific markets, which are entirely long-
haul, with virtually no opportunity for modal substitution.
iii) Geographic Market Analysis
The econometric analysis of the IATA PaxIS Plus data
found statistically significant differences between
different geographic air travel markets. The estimated
elasticity multipliers for each market, along with the
reasons for why it is needed, are:
• Intra North America. This is our reference point
with an elasticity multiplier of 1. The market is well
established with relatively high levels of capacity and
traffic. Air travel prices tend to be low, while distances
are short to medium haul.
06 - Air Travel Demand 27
• Intra Europe. Traffic in this region is estimated to be
more elastic, with an elasticity multiplier of 1.4. Intra
European routes typically have shorter average travel
distances, strong competition from other transport
modes and the use of very low prices in several
markets. The high market share of charter airlines is
being eroded by very low fare LCCs.
• Intra Asia. Moderately more inelastic estimates were
found in this region, with an elasticity multiplier of
0.95. LCCs are now emerging in Asia but average
distances are longer, and the key middle class is still
relatively small in many markets in this region.
• Intra Sub-Saharan Africa. This region is estimated to
have a relatively inelastic demand compared to North
America, with an elasticity multiplier of 0.6. African
economies have a much smaller middle class. Travel
is concentrated among higher income individuals who
are less price-sensitive.
• Intra South America. This region is estimated to be
at the more elastic end of the scale, with an elasticity
multiplier of 1.25. There is an emerging middle class
making the region more price elastic plus LCCs are
emerging in Brazil, Chile and Mexico.
• Trans Atlantic (North America – Europe). A high
price elasticity was found for this market, with an
elasticity multiplier of 1.2. This market has long been
developed by low fare charter airlines. Price is likely
more important than frequency in this market than in
US domestic markets
• Trans Pacific (North America – Asia). By contrast,
markets across the Pacific are estimated to have a
much less elastic response, with an elasticity multiplier
of 0.6. There are no charter services and there remain
markets with less liberal pricing regulation. There are
early signs of long-haul LCCs emerging but at present
this market shows much less sensitivity to travel cost
than the US domestic market or the trans Atlantic
market.
• Europe – Asia. This market is estimated to be slightly
less price sensitive, with an elasticity multiplier of
0.9. This result is in contrast to the results found in
the respective intra markets of Europe and Asia, and
provides further evidence for lower elasticities on long-
haul and intercontinental air transportation.
Applying the Elasticity Estimates and Multipliers
Table 3 provides a guideline for the estimated price demand elasticity by level of aggregation and by region. It
multiplies the estimate for the relevant level of aggregation by the relevant short-haul and geographic elasticity
multipliers.

Table 3: Estimated Price Elasticities of Passenger Demand

Route/Market level National level Supra-national level

Short-haul Long-haul Short-haul Long-haul Short-haul Long-haul

Intra N America -1.5 -1.4 -0.9 -0.8 -0.7 -0.6

Intra Europe -2.0 -2.0 -1.2 -1.1 -0.9 -0.8

Intra Asia -1.5 -1.3 -0.8 -0.8 -0.6 -0.6

Intra Sub-Saharan -0.9 -0.8 -0.5 -0.5 -0.4 -0.4

Africa
Intra S America -1.9 -1.8 -1.1 -1.0 -0.8 -0.8

Trans-Atlantic -1.9 -1.7 -1.1 -1.0 -0.8 -0.7

Trans-Pacific -0.9 -0.8 -0.5 -0.5 -0.4 -0.4

Europe-Asia -1.4 -1.3 -0.8 -0.7 -0.6 -0.5

Inbound vs Outbound Price Elasticities

One further adjustment that may need to be applied to
the price elasticity estimates in table 3 is for the case
when the passenger flow of concern is inbound or
outbound, not the total or average impact. This will be
of particular importance when considering the impact on
inbound tourism of, for example, a national passenger tax.
It also matters when considering the diversion of inbound
passengers and consequent reduction of effectiveness
of a national or regional environmental tax.
The price elasticity estimates in table 3 are all averages
of outbound and inbound passengers. Most databases of
passenger numbers and fares do not distinguish between
domestic residents travelling overseas then returning,
and overseas residents visiting and then returning home.
However, their sensitivity to travel prices including taxes
will differ.
Faced by a passenger or environmental tax the outbound
passenger must either pay or not travel. However, the
inbound overseas passenger can choose to travel to a
different destination or transit by another hub and avoid
the tax. This is particularly the case for holiday travel or
transfer and transit passengers, which are much more
price sensitive than travel for business or visiting friends
and relatives. Inbound travel originating from overseas
will be more price sensitive i.e. will have a larger price
elasticity in absolute terms, than outbound travel.
For example the UK in 2006 had 185.5 million
international arrivals or departures from UK airports, 61%
of which were arrivals or departures by UK residents and
39% by overseas residents or passengers transferring
and transiting. Of these passengers 77% were travelling
on short-haul trips to Europe, 9% transatlantic and 14%
other long-haul. Using the elasticities in table 3 an
average price elasticity for UK inbound and outbound
travel can be derived of -1.0.

Njegovan (2006) found that UK residents travelling
overseas for leisure had a price elasticity of -0.7 to -0.8.
Business travel will be less elastic. So a conservative
estimate for the price elasticity (Pe) of inbound travel by
overseas residents can be derived as follows:
Peoverseas residents * % overseas residents +
PeUK residents * % UK residents = average Pe
Peoverseas residents * 39% + -0.8 * 61% = -1.0
Peoverseas residents = -1.3
These estimates will be verified by future research.
Meanwhile a reasonable rule-of-thumb multiplier to adjust
the price elasticities in table 3 is as follows:
Inbound travel by overseas residents = -1.3/-1.0 of demand to changes in incomes. The econometric
= 1.3 * table 3 price elasticity
Outbound travel by domestic residents = -0.8/-1.0
= 0.8 * table 3 price elasticity
By way of illustration, elasticities for different situations
can be developed by selecting the relevant base elasticity
and applying the relevant multipliers. For example:
• To examine the impact of an EU-wide aviation tax on
short-haul markets, the elasticity would be developed
as follows:
- Base multiplier: -0.6 (supra-national)
- Geographic market: 1.4 (Intra Europe)
- Short-haul adjustor: 1.1
The price elasticity would then be calculated as:
-0.6 x 1.4 x 1.1 = -0.92
• To examine the impact of a UK tax on aviation
on Trans Atlantic traffic, the elasticity should be
developed as follows:
- Base multiplier: -0.8 (national)
- Geographic market: 1.2 (Trans Atlantic)
The price elasticity would then be calculated as:
-0.8 x 1.2 = -0.96
• To examine the impact of the same tax on overseas
visitors and tourism:
- Overseas resident adjustor: 1.3
The price elasticity would then be calculated as:
-0.96 x 1.3 = -1.25
06 - Air Travel Demand 29
• To examine the impact of an increase in airport landing
fees on a particular short-haul route in Asia, the
elasticity should be developed as follows:
- Base multiplier: -1.4 (route)
- Geographic market: 0.95 (Intra Asia)
- Short-haul adjustor: 1.1
The price elasticity would then be calculated as:
-1.4 x 0.95 x 1.1 = -1.46.
Income Elasticities
The main focus of the research was on price elasticities.
Nevertheless, the analysis also considered the sensitivity
research and review of previous estimates found that air
transport income elasticities were consistently positive and
greater than one. This suggests that as households and
individuals get more prosperous, they are likely to devote
an increasing share of their incomes to discretionary
spending such as air travel.
The statistical evidence suggests:
• Developed country travel markets have base income
elasticities for short-haul routes of around 1.5. At the
national level, this declines to an estimated income
elasticity of 1.3.
• US travel markets have slightly higher income
elasticities with air travel perhaps less budget-oriented
than in other developed economies. Using the DB1A
data suggests short-haul route income elasticities of
1.8 at the route level and 1.6 at the national level.
• There is some evidence that income elasticities
decline as countries become richer and markets
mature. Developing countries typically have a greater
responsiveness, with an estimated short-haul income
elasticity of around 2.0 at the route level and 1.8 at the
national level.
• There is also evidence that long-haul journeys are
seen by passengers as different, more desirable, to the
more commoditised short-haul markets, and so income
elasticities are higher the longer the distance. This
suggests that middle to lower income individuals are
more likely to travel on short to medium haul routes,
with higher incomes leading to a higher frequency of
long-haul travel.
The income elasticity results are based on information
from the review of previous studies and results from the
new econometric research. Table 4 outlines the estimated
income elasticities for different markets at the route and
at the national level.
Table 4: Estimated income elasticities of passenger demand

Route/market level Short-haul Medium-haul Long-haul Very long-haul

US 1.8 1.9 2.0 2.2
Developed 1.5 1.6 1.7 2.4
economies
Developing 2.0 2.0 2.2 2.7
economies
National level Short-haul Medium-haul Long-haul Very long-haul

US 1.6 1.7 1.8 2.0

Developed 1.3 1.4 1.5 2.2
economies
Developing 1.8 1.8 2.0 2.5
economies

If passengers are relatively insensitive to air travel prices

at a national aggregate market level, and even less so at
a supra-national level, this strongly suggests that falling
real air travel prices have not been the main driver of air
travel growth11. Falling real air travel prices are important
in passengers switching from one airline to another,
and from one destination to another, but are much less
important in driving aggregate national-level air travel or
tourism growth.

The growth of incomes, often proxied by GDP, has been

found to be the fundamental driver of the demand for
air travel. During the past twenty years global passenger
traffic has expanded at an average annual growth rate of
5.1%, while global GDP grew by an average annual rate
of 3.7% over the same period. That implies an average
income elasticity of 1.4, similar to the average estimated
above for developed economies. The implication is that
economic growth can explain most of the expansion
in air travel seen in the past twenty years. The fall in
real air travel prices has played a part, but mostly in
diverting travel between airlines and markets rather than
significantly boosting overall travel volumes. In addition,
economic growth is now increasingly being driven by
developing economies, where income elasticities are
higher. Therefore, the underlying drivers for overall
air travel growth are likely to remain strong for the
foreseeable future.

11
This conclusion is reached in a recent study of the UK market (UK CAA, 2006, No frills carriers; revolution or evolution). It concludes that “despite
the spectacular growth of no-frills carriers in the UK, and the perceptions about the impact they have had on travel habits, there has been little
change in long-term aggregate passenger traffic growth rates”.
07 Policy

Implications
Air transport policy decisions run the risk
of being ineffective, or even counter-
productive, if the correct demand elasticity
is not used. A revenue-raising policy to
raise the cost of travel on a route will
be ineffective if the demand elasticity is
underestimated. An environmental policy
to raise the price of travel on a national or
supra-national basis will be ineffective if
the demand elasticity is overestimated.

Addressing the correct elasticity
to the appropriate question
This report shows how the sensitivity of air travel demand
to prices and incomes can vary according to different
situations. Therefore, the appropriate elasticity to use will
depend upon the level of aggregation and the location of
an air transport policy proposal. For example:
• At the Route level. To examine the impact of an
increase in airport landing fees on a particular short-
haul market in South America, the price elasticity
would be derived as:
Base elasticity -1.4 (route) raising the price of air travel, are likely to fail. Tourists
multiplied by 1.25 (intra South America) are shown to be very sensitive to prices for air travel on
multiplied by 1.1 (short-haul multiplier) competing airlines or to alternative destinations. However,
which equals -1.93
A 10% rise in the airport landing fee would reduce
passenger numbers on short-haul markets serving that
airport by over 19%.
• At the National level. To look at the impact of the
doubling of UK passenger tax on trans Atlantic traffic,
the price elasticity would be derived as follows:
Base elasticity -0.8 (national) infrastructure and operations.
multiplied by 1.2 (trans Atlantic geographical multiplier)
which equals -0.96
For outbound traffic from the UK this implies the resulting
3.7% rise in the cost of long-haul travel will cut demand
by 3.6%. For inbound traffic from N America the UK only
represents a 20% market share, so while the UK will
lose inbound tourists many will just be diverted to other
destinations.
• At the Supra-national level. To look at the demand
impacts of higher travel costs caused by extending the
EU Emissions Trading Scheme just to intra-EU travel
i.e. short-haul markets, the relevant price elasticity
would be derived as follows:
Base elasticity -0.6 (supra-national) multiplied by
1.4 (intra-Europe geographic multiplier) multiplied
by 1.1 (short-haul multiplier) which equals -0.92
So a 10% rise in intra-EU travel costs would lead to a
relative inelastic 9.2% reduction in air travel.
12
Building a Greener Future (2007) IATA.
07 - Air Travel Demand 33
Demand Elasticities and Environmental Policy
The focus of existing policy to reduce CO2 emissions
from air travel has been on trying to manage air travel
demand by raising the price of travel for passengers.
Even the recent debate on emissions trading in Europe
has focused on the costs it will impose on airlines and
their passengers.
The results contained in this report show that policies that
aim to reduce emissions by managing demand, through
at the national or supra-national level these choices
cancel each other out and the overall market is much less
sensitive to the cost of air travel. It is economic growth and
incomes that are found to have been the key drivers of air
travel demand, and those drivers are expected to remain
particularly strong in the developing markets of Asia.
Decoupling emissions from travel growth needs to focus
not on demand management but on mechanisms to bring
about emission reduction measures from technology,
Climate policies will need to focus on creating incentives
where there can be effective investment in emissions
reductions. The major potential would appear to be on
decoupling emissions from travel growth, through supply-
side innovations, rather than trying to manage demand
through raising the price of travel.
There is a need to look beyond rudimentary economic
instruments (e.g. passenger taxes) that seek to manage
demand by raising the price of travel for the passenger in
order to incentivise effectively the various players along
the air transport value chain who can invest in emission
reduction.
IATA’s four pillar climate strategy12, which was endorsed
by the Assembly of the International Civil Aviation
Organisation in 2007, focuses action on emission
reduction measures from technology, infrastructure,
operations and those brought about by well designed
economic instruments.
By contrast, Table 5 shows that:
• Passenger taxes are ineffective for reducing CO2
emissions. This is not just because demand is relatively
price insensitive at a national and supra-national
level. It is also because raising the cost of travel
for the passenger does nothing to incentivise the
manufacturer to produce new airframes or engines,
nothing to incentivise the fuel company to produce a
clean fuel, nothing to incentivise the EU to implement
a Single European Sky, nothing to incentivise ANSPs
to straighten routes and reduce stacking, nothing to
incentivise airports to reduce taxiing emissions, and
nothing to incentivise airlines to improve operations
and renew their fleet.
• Emissions trading can be more effective, if well
designed. By a direct linkage to emissions it
incentivises operational and fleet improvements.
If well designed, to be open to trading with other
industries and global, it allows the reduction of CO2
emissions to take place in industries where reductions
are most efficient. However, even emissions
trading has little impact on the key technology and
infrastructure pillars.
Effectively decoupling emissions from air travel growth
will require policy-makers and the industry to look beyond
simple economic instruments:
• Technology progress will require collaboration across
the value chain and across countries.
• Governments will need to play a role in funding
fundamental research.
• Political will is perhaps one of the most important
mechanisms for delivering emissions reductions from
infrastructure improvements.
• The lack of implementation of a Single European
Sky is one glaring omission in policy action to reduce
emissions from air travel.
IATA is actively promoting collaborative efforts on
technology and is lobbying hard for Governments to
improve infrastructure. On operations there is a major
initiative to spread best practice. More needs to be done
in the face of the challenge of climate change, but the
airline industry is already stepping up its efforts with a
bold vision of zero emissions and an important future
milestone of carbon-neutral growth. The key lesson for
both policy-makers and the industry is to look beyond
simple economic instruments for mechanisms to bring
about an effective reduction in emissions from air travel.

Table 5: The effectiveness of existing economic instruments

Emission cut measure Player Passenger tax Emissions trading
TECHNOLOGY Manufacturer No impact No impact
Fuel company No impact No impact
INFRASTRUCTURE Government No impact No impact
ANSP No impact No impact
Airport No impact No impact
OPERATIONS/FLEET Airline No impact Impact
REDUCED DEMAND Passenger Minor impact Minor impact
CUTS ELSEWHERE Other industry No impact Impact
08 Conclusions

The correct elasticity value to use in

analysing an air transport policy decision
depends on the type of question being
asked. The impact on demand of higher
travel prices on a given route due to a
rise in airport landing charges requires
a different (higher) elasticity than when
examining the traffic impact of a wider
travel price increase due to a passenger
tax on all routes in a country.
 08 - Air Travel Demand 37

This report uses new econometric research and a Thus, the particular elasticity value to be used for
review of previous studies to provide guidelines on the analysing price effects in airline markets depends
appropriate level and type of demand elasticity to use on the question being asked. The narrower the
when analysing a policy proposal. It provides robust applicability of a price change, the more elastic (i.e.
elasticity estimates to ensure that policy decisions larger) the change in demand. The more general the
related to issues such as liberalisation, airport charges, applicability of a price change (perhaps due to higher
taxation, and emissions schemes, are made on the costs or taxes) the less elastic (i.e. smaller) the change
basis of appropriate and reliable evidence. It provides in demand.
important new estimates to ensure that price elasticity
estimates do not underestimate the sensitivity of
passengers to price and are used correctly.
Different air travel demand elasticities are associated
with different uses. When consumers are choosing
between airlines on a route, or even between
destinations for travel, there is a degree of price
elasticity for airline seats. However, if all competitors
on a route, or if a wide range of routes all experience
the same proportionate price increase, the demand for
airline services becomes less elastic. As a price increase
is extended to ever larger groups of competing airlines
or competing destinations, then the overall demand for
air travel is revealed to be somewhat inelastic.
The implications are:
• For an airline on a given route, increasing price is
likely to result in a more than proportionate decrease
in air travel. Lower travel prices will greatly stimulate
traffic and raise revenues. Airline specific travel price
charges are price elastic.

• If all airlines on a given route increase travel prices

by the same amount (e.g. due to the imposition of
passenger based airport fees that are passed on to
the consumer), then the decrease in traffic will be less
but still proportionately more than the change in price.
Route specific travel prices are price elastic.

• If all airlines on a wide set of routes increase travel

prices by roughly similar amounts (e.g. due to the
imposition of new market-wide taxes or to the working
through of higher fuel or security costs) then the
decrease in traffic may be less or much less than
proportional to the increase in fares. National or
Supra-National increases in airline travel prices, that
take place across a broad range of markets, are price
inelastic.
ANNEX A: THE INTERACTION BETWEEN
PRICE ELASTICITIES
The relationship between the price sensitivity at the
aggregate market level E and at destination-specific
route levels (own-price elasticity Eii and cross-price
elasticity Eij) is described in a study carried out by the UK
CAA13 as:
E = Σi Si (ΣjEij)
where Si is the traffic share of destination i.
An hypothetical example will help illustrate the implications
for policy. Assume there are just two routes for a national
market, A and B with own-price elasticities EA = -1.4 and
EB = -1.4. Own-price elasticities indicate for instance
that a 10% rise in air fares just on route A would lead to
a 14% decline in passengers on that route. Cross-price
elasticities are, say, EAB = 0.6 and EBA = 0.6. This means
that, for instance, the 10% rise in air fares just on route A
would, as well as causing a 14% decline in passengers on
route A, boost passengers on route B by 6%. Therefore,
a price rise does not just suppress demand, it diverts it to
another route. This clearly affects the overall net impact.
If both routes have a market share Si of 50% then the
weighted average national own-price price elasticity is
-1.4. This might suggest that a policy that raises the cost
of air travel nationwide by 10% would reduce air travel
volumes by 14%. However, that conclusion would be
wrong. To see why, using the expression for aggregate
elasticity above:
E = SA(EA + EAB) + SB(EB + EBA)= 0.5(-1.4 + 0.6) +
0.5(-1.4 + 0.6) = -0.8
This shows that the aggregate price elasticity is not -1.4
but -0.8 i.e. the reduction in passengers to a 10% rise in
air fares is not 14% but 8%. This is a relatively inelastic
or price insensitive response. Table A1 uses the same
example to work through the effects:
Table A1: Impact of fare increases at the route and market level
Effect on route A
10% rise in air fare A -14%
10% rise in air fare B +6%
Net effect -8%
13
Demand for Outbound Leisure Air Travel and its Key Drivers (December 2005) UK CAA.
The effect of a 10% fare increase on both routes (for
instance caused by a rise in a national passenger tax)
would be to reduce the total traffic in the market by 8%
(the weighted average of the route net effects), which is
exactly what is implied by the aggregate market elasticity
of -0.8. Using the weighted average elasticity of -1.4, on
the other hand, would incorrectly imply a 14% decrease
in aggregate air travel.
This example considers the impact on outbound leisure
passengers, where a rise in passenger tax will affect
all destination choices. That is not the case for inbound
tourists. The choice facing US residents in travelling to
destination A, say the UK, or destination B, say Italy will
be significantly affected by national passenger taxes.
For example, the recent doubling of the UK passenger
departure tax added roughly 4% to the cost of travel. This
will have had a relatively inelastic impact (-3.2%) on UK
residents departing on overseas holidays, for the reasons
set out above. However, it will have led to an elastic impact
(-5.6%) on the choice of US residents travelling to the
UK. Many will have been diverted to holiday in, say, Italy.
In total, this demand response would significantly limit
the effectiveness of national passenger taxes as a way of
managing demand or limiting the rise of greenhouse gas
emissions from air travel.
Effect on route B
+6%
-14%
-8%
 Air Travel Demand 39

ANNEX B: LIST OF PREVIOUS Oum, Zhang, and Zhang (1993), Inter-Firm Rivalry and
Firm-Specific Price Elasticities in Deregulated Airline
STUDIES REVIEWED Markets.

Abed, Ba-Fail and Jasimuddin (2001), An Econometric
Analysis of International Air Travel Demand in Saudi
Arabia.
Abrahams (1983), A Service Quality Model of Air Travel
Demand: An Empirical Study.
PriceWaterhouseCoopers (2005), Aviation Emissions
and Policy Instruments, Final Report.
Rubin and Joy (2005), Where are the Airlines Headed?
Implications of Airline Industry Structure and Change for
Consumers.

Alperovich and Machnes (1994), The Role of Wealth in Taplin (1980), A Coherence Approach to Estimates of
the Demand for International Air Travel. Price Elasticities in the Vacation Travel Market.

Australian Bureau of Transport and Communications Taplin (1997), A Generalised Decomposition of Travel-
Economics (1995), Demand Elasticities for Air Travel to Related Demand Elasticities into Choice and Generation
and from Australia. Components.

Bros, Pels, Nijkamp and Rietveld (2002), Price Elasticities

of Demand for Passenger Air Travel: A Meta-Analysis.

Carlsson (1999), Private vs. Business and Rail vs. Air

Passengers: Willingness to pay for Transport Attributes.

Castelli, Pesenti, Ukovich (2003), An Airline-Based

Multilevel Analysis of Airfare Elasticity for Passenger
Demand.

Cohas, Belobaba, and Simpson (1995), Competitive

Fare and Frequency Effects in Airport Market Share
Modeling.

Gillen, Morrison and Stewart (2002), Air Travel Demand

Elasticities: Concepts, Issues and Measurement.

Goolsbee and Syverson (2006), How Do Incumbents

Respond to the Threat of Entry? Evidence from the Major
Airlines.

Hamal (1998), Australian Outbound Holiday Travel

Demand Long-haul Versus Short-haul.

Jorge-Calderon (1997), A Demand Model for Scheduled

Airline Services on International European Routes.

New Zealand Commerce Commission (2002), Final

Report Part IV Inquiry into Airfield Activities at Auckland,
Wellington and Christchurch International Airports.

Njegovan (2006), Elasticities of Demand for Leisure Air

Travel: A System Modelling Approach.

Oum, Gillen, and Noble (1986), Demands for Fareclasses

and Pricing in Airline Markets.

Oum (1989), Alternative Demand Models and their

Elasticity Estimates.
ANNEX C: ECONOMETRIC MODEL
SPECIFICATIONS
Ordinary Least Squares
Ordinary Least Squares (OLS) regression analysis is
a method relating passenger traffic to air travel prices,
income (GDP) levels, and other variables that have
an intuitive and measured impact on air travel, while
minimising the variance (randomness) of the estimates.
The regression analysis allows the relationship between
traffic and air travel price to be isolated and quantified
while controlling for other factors that may impact on air
travel, such as gross domestic product, population levels,
route distance and seasonality.
InterVISTAS used OLS techniques with a log-log model
formulation, as follows14:
ln(Traffic) = Constant + a1 x ln(Price) + a2 x
ln(Var2) + … + an x ln(VarN) + an+1 x Dummies
Where: instead of an instrument (if route distance is believed
• Traffic is the dependent variable,
• Price is the average economy or leisure air travel price.
Two-Stage Least Squares
Two-stage least squares (2SLS) is a regression technique
that is used when explanatory variables are believed to be
correlated with the regression model’s error term used to
obtain consistent estimators15. One or more instrumental
variables (IVs) that are correlated with the endogenous
explanatory variable, but uncorrelated with the dependent
variable are used to isolate the effects of the endogenous
explanatory variable. This process increases consistency
(relative to OLS), at the expense of increasing sample
variance.
InterVISTAS experimented with the use of two-stage
least squares techniques to improve the consistency of
elasticity estimates. The natural logarithm of distance
and the natural logarithm of fuel prices were used
separately and combined as potential IVs. In some
data sets, distance was found to be a worthwhile IV,
exhibiting high correlations with travel prices and low
correlations with traffic. However, there is some concern
that distance should be used as an explanatory variable
to have an impact on traffic). Fuel prices were found to
be poor IVs. Fuel prices exhibited low correlations with
traffic and travel prices.

• Var2 to VarN are other quantifiable explanatory

variables that affect traffic levels.

• ln( ) refers to the variables inside of the parentheses

transformed by the natural logarithm.

• The dummies are variables that take the form of 1

or 0 in any observation and capture any remaining
structural reasons for traffic differences between
routes.

The regression analysis estimates the value of the

parameters (constant, a1, a2, a3, a4, a5, etc.) on each of the
variables, which reflect the relative impact of each of the
variables on traffic levels. As log formulations approximate
percentage changes in impacts, the parameters of the
logged independent variables can be directly interpreted
as elasticities.

14
Log-log model formulations refer to a model specification where both the dependent (left hand side) and independent (right hand side) vari-
ables have been transformed by the natural logarithm.
15
A consistent estimator in a regression analysis is defined as an estimator that converges in probability to the correct parameter as the
sample size grows.
 Air Travel Demand 41

Autoregressive Distributed Lag

An autoregressive distributed lag (ARDL) model was
developed and used with OLS regression analysis. Traffic
was regressed onto similar explanatory variables as in prior
models, but also onto lagged values of traffic. The inclusion
of lagged values of the dependent variable (traffic) is
done to account for the slow adjustment of supply (in the
form of capacity) to changes in the explanatory variables.
The applicability of this assumption is less reasonable for
the U.S. domestic market as the barriers to expanding
capacity are fewer than on international routes; the U.S.
domestic market was therefore excluded from ARDL
estimation16.

InterVISTAS experimented with the use of ‘prior period’

and ‘year over year’ lags. Although both showed some
degree of success in controlling for these factors, ‘year
over year’ lags had higher correlations with current traffic
levels than ‘prior period’ lags, and were determined to be
the preferred form of lagged variable.

The ARDL models used a formulation as follows:

ln(Traffic t ) =
Constant + b1 x ln(Traffic t-1 ) + b2 x ln(Price t )
+ b3 x ln(Var3 t ) + … + bn x ln(VarN t )
+ bn+1 xDummies t
Where:

• Traffic t is the dependent variable,

• Traffic t-1 is the traffic in the same month (or quarter)

of the previous year

• Price is the average economy or leisure air travel price.

• Var2 to VarN are other quantifiable explanatory

variables that affect traffic levels.

• ln( ) refers to the variables inside of the parentheses

transformed by the natural logarithm.

• The dummies are variables that take the form of 1

or 0 in any observation and capture any remaining
structural reasons for traffic differences between
routes.

Since traffic appears on both sides of the equation,

the coefficients on the explanatory variables cannot be
directly interpreted as long-run elasticities. The long-run
elasticities are defined as when traffic across time periods
stabilise. In general, the use of ARDL models tended to
produce more elastic price elasticity estimates with much
higher goodness of fit values.

16
The U.S. domestic market is not constrained by air bilateral agreements, has a wide access to capital, and high levels of competition, all of
which increase responsiveness to changes in the explanatory variables (travel price, income, and population).
Understanding the impact
on demand is the key to
effective policy decisions
concerning aviation.
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